‘Major worldwide recession’ could follow if U.S. defaults on debt
House of cards. For the first time in the country's history, the United States could be forced to default on the national debt if a deal cannot be reached in Congress.
UPDATE: U.S. Senate leaders reached a temporary deal Wednesday to avoid a default.
When there’s trouble on Capitol Hill, the world takes notice.
With the United States’ national debt ceiling fast approaching, Congress is scrambling to reach a deal that would increase the country’s $16.7 trillion debt limit and temporarily reopen the government. However, if the current borrowing limit is not extended and the U.S. defaults on its loan repayments, the country could plunge into an economic recession.
Atif Kubursi, a professor emeritus in the Department of Economics, sheds some light on the United States’ financial crisis and what it means for Canadians:
How did the United States accumulate a staggering $16.7 trillion in debt?
The debt was accumulated over a long period of time as deficits (government spending exceeding tax revenues) were incurred annually. Three main factors can explain this: a high annual defence budget in the area of $700 billion; the high cost of the wars in Afghanistan, Iraq and the War on Terror; and large interest payments on existing debt. In 2006, the national debt was less than half of what it is today.
Why is October 17 an important date?
After this date, the U.S. Treasury has no authorized funds to pay back debt to holders of Treasury bills and government bonds. Should this happen to the U.S. government, they will be technically defaulting on debt obligations.
What will happen if the United States starts defaulting on its debt repayments?
Should this happen, the consequences could make the recession in 2008 seem like a minor occurrence. The U.S. dollar is the financial anchor of the world economy. Any default will persuade investors in bonds and Treasury bills that these assets are defunct and unworthy of their value. Unfortunately, most of these U.S. bonds and bills appear as assets on the balance sheets of banks around the world. Without these American financial anchors, there will a desperate attempt to find an alternative. The fallout, should this happen, could be disastrous.
Is it a wise decision for Congress to push the debt ceiling even higher, to avoid a default?
It makes sense to avoid the catastrophic upheaval a default will cause. Each week, the government shutdown shaves between 0.1 and 0.2 of 1 per cent off the growth of the U.S. economy, and there isn’t much left to shave off.
Is another recession inevitable? How large will it be?
If the debt ceiling is not revised and the government shutdown continues, a major worldwide recession can be expected. The global economy is interlinked, and a sneeze in the United States could generate flu epidemic around the world.
How concerned should Canadians be about these issues?
They should be very concerned, as 80 per cent of our trade is with the United States. Our banking system is strongly tied to American financial markets, and the Canadian dollar could be directly affected by a U.S. recession. As credit dries up, a rise in the interest rate in Canada could have severe ripple effects in real estate markets and other financial dealings. Slow growth in the U.S. will also affect our exports. This, combined with an unexpected appreciation of the Canadian dollar, could derail our economic growth and sink Canada into a major recession.
